So it’s especially noteworthy that economists at the European Central Bank have just produced a study showing that government spending is unambiguously harmful to economic performance. Here is a brief description of the key findings.

…we analyse a wide set of 108 countries composed of both developed and emerging and developing countries, using a long time span running from 1970-2008, and employing different proxies for government size… Our results show a significant negative effect of the size of government on growth. …Interestingly, government consumption is consistently detrimental to output growth irrespective of the country sample considered (OECD, emerging and developing countries).

The second key takeaway is that Europe’s corrupt political elite is engaging in a classic case of Mitchell’s Law, which is when one bad government policy is used to justify another bad government policy. In this case, they undermined prosperity by recklessly increasing the burden of government spending, and they’re now using the resulting fiscal crisis as an excuse to promote inflationary monetary policy by the European Central Bank.

The ECB study, by contrast, shows that the only good answer is to reduce the burden of the public sector. Moreover, the research also has a discussion of the growth-maximizing size of government.

… economic progress is limited when government is zero percent of the economy (absence of rule of law, property rights, etc.), but also when it is closer to 100 percent (the law of diminishing returns operates in addition to, e.g., increased taxation required to finance the government’s growing burden – which has adverse effects on human economic behaviour, namely on consumption decisions).

This may sound familiar, because it’s a description of the Rahn Curve, which is sort of the spending version of the Laffer Curve. This video explains.

The key lesson in the video is that government is far too big in the United States and other industrialized nations, which is precisely what the scholars found in the European Central Bank study.

Another interesting finding in the study is that the quality and structure of government matters.

Growth in government size has negative effects on economic growth, but the negative effects are three times as great in non-democratic systems as in democratic systems. …the negative effect of government size on GDP per capita is stronger at lower levels of institutional quality, and ii) the positive effect of institutional quality on GDP per capita is stronger at smaller levels of government size.

The simple way of thinking about these results is that government spending doesn’t do as much damage in a nation such as Sweden as it does in a failed state such as Mexico.

Last but not least, the ECB study analyzes various budget process reforms. There’s a bit of jargon in this excerpt, but it basically shows that spending limits (presumably policies similar to Senator Corker’s CAP Act or Congressman Brady’s MAP Act) are far better than balanced budget rules.

…we use three indices constructed by the European Commission (overall rule index, expenditure rule index, and budget balance and debt rule index). …The former incorporates each index individually whereas the latter includes interacted terms between fiscal rules and government size proxies. Particularly under the total government expenditure and government spending specifications…we find statistically significant positive coefficients on the overall rule index and the expenditure rule index, meaning that having these fiscal numerical rules improves GDP growth for these set of EU countries.

This research is important because it shows that rules focusing on deficits and debt (such as requirements to balance the budget) are not as effective because politicians can use them as an excuse to raise taxes.

At the risk of citing myself again, the number one message from this new ECB research is that lawmakers – at the very least – need to follow Mitchell’s Golden Rule and make sure government spending grows slower than the private sector. Fortunately, that can happen, as shown in this video.

But my Golden Rule is just a minimum requirement. If politicians really want to do the right thing, they should copy the Baltic nations and implement genuine spending cuts rather than just reductions in the rate of growth in the burden of government.

28 Responses

Were the Newtser to take on the philosophy espoused here, I would forgive all and vote for him in a minute, even with all the baggage and inconsistant history. Hard to argue with the results of a retrospective study.
Ultimately, adopting the approach of cutting spending as you detailed in this column will prevail as the only workable solution. The question is whether we take it on as we are now, grudgingly, reluctantly and with much pissing and moaning, but with the bones of our republic mostly intact and salvageable? Or do we wait past the last minute, after the collapse of the dollar, after the weeks or months of disruption of our economic system, after Soros has sucked billions of equity out of our country, after the imposition of martial law in response to riots by folks that only understand that things have stopped, after Presbo has tried to impose central committee control because the over-regulated, over-taxed non-free, “free enterprise” system that we have is not working.
The problem that the lib/progs have is that every time that the govenment has radically cut spending and taxes, along with all the regulations, our economy has taken off in less than a year. Gangbusters. They don’t like it, but there it is. So if they are not careful, if people started demanding that,they would have a hard time continuing the massive spending towards collapse, because, after all, it is not the LAST minute yet. And they can still get their own personal benefit out of continuing the staus quo, even if at the cost of selling out the country.

Wow, just as the ECB and bankster community realise we are non to them about how criminal the “austerity measures” they insist on are, they manage to come up with this “research”. Keeping a lid on Big Government is one thing but this is murky beyond belief. Like, wow …. Can someone please help me zip the back of my head up please??

[…] some people in Europe understand this issue, including economists at the European Central Bank who recently produced a study finding that, “…using a long time span running from 1970-2008, and employing different […]

[…] some people in Europe understand this issue, including economists at the European Central Bank who recently produced a study finding that, “…using a long time span running from 1970-2008, and employing different proxies […]

[…] Organization for Economic Cooperation and Development, International Monetary Fund, World Bank, and European Central Bank. And since most of those organizations lean to the left, these results should be particularly […]

[…] Organization for Economic Cooperation and Development, International Monetary Fund, World Bank, and European Central Bank. And since most of those organizations lean to the left, these results should be particularly […]

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[…] Organization for Economic Cooperation and Development, International Monetary Fund, World Bank, and European Central Bank. And since most of those organizations lean to the left, these results should be particularly […]

[…] from international bureaucracies such as the International Monetary Fund, World Bank, and European Central Bank. And since most of those organizations lean to the left, these results should be particularly […]

[…] Organization for Economic Cooperation and Development, International Monetary Fund, World Bank, and European Central Bank. And since most of those organizations lean to the left, these results should be particularly […]